1 / 7

The Relationship between Bond Prices and Interest Rates

The Relationship between Bond Prices and Interest Rates. As interest rates change, the value of existing bonds go either up or down. If interest rates increase, the value of bonds sold at lower interest rates decline in value.

jada
Télécharger la présentation

The Relationship between Bond Prices and Interest Rates

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. The Relationship between Bond Prices and Interest Rates • As interest rates change, the value of existing bonds go either up or down. • If interest rates increase, the value of bonds sold at lower interest rates decline in value. • If interest rates decline, the value of bonds sold at higher interest rates increase in value. • Example: On September 1, 2012 you buy a $1000

  2. An Example • On September 1, 2012 you buy a $1,000 bond with a 10% coupon paid annually, with a two-year maturity. • This bond will pay you $50 interest at 6 months, another $50 interest at 12 months, another $50 at 18 months, and another $50, plus $1,000 at the end of month 24.

  3. What Happens If Interest Rates Go Up before your Bond matures? • If you hold the bond until it matures, nothing. You will receive the interest payments and the principle as contracted. • However, if you want to sell the bond before it matures, you will have to sell it at a discount. • The reason is that buyers can now purchase bonds with a higher interest rate than the one you are receiving.

  4. What Happens If Interest rates go down? • Again, as long as you are holding, nothing. • However, if you want to sell the bond before maturity, its value will have increased. • The reason is that your bond is paying better that new bonds.

  5. How Do We Calculate these Values? • Let’s make an easy example. • We will use a Zero Coupon Bond. • With this type of bond you purchase it at a discount, hold it to maturity, and at maturity you receive your original investment plus earned interest.

  6. A Zero Coupon Bond • Let’s say you buy a bond with a face value of $1,000, with an interest rate of 10%, and a two year maturity. • How much should this bond cost? • P is the price you will pay • P (1.10) (1.10) = $1,000 • P (1.1)2 = $1,000 • P = 1000 • _____ • (1.1)2 = $826.00 • If you pay this for the bond, when it matures at $1,000, you earned 10%.

  7. If Interest rates change and you want to sell • Interest rates go up to 15% • P= 1000 • __________ • (1.15)2 = $756.00 • Interest Rate goes down to 5% • P= 1000 • ____________ • (1.05)2 = $907

More Related